The Real Estate Espresso Podcast

Today is another AMA episode (Ask Me Anything). Ryan in Los Angeles asks: “I'm astounded by your prolific podcasting and breadth of knowledge. You seem to be inside my head in that whenever I think of a question to ask, I usually find the answer by listening to earlier episodes of your podcast. Please keep up the amazing work. Where do you go to or what do you use to curate your summary of daily or weekly news sources you read to stay abreast of your real estate and related economic news?  I find myself being overwhelmed by having to pick certain sites (e.g., REIS, NMHC, John Burns Consulting, Marcus & Millichap, etc.) to read each week.” This is a great question. Developing content for the show is an intentional process that consists of a balance of topics of different types. As much as possible, I would like the content to be evergreen, that is to say, timeless. Some episodes are precisely that, a timeless piece of content on a particular topic. For example, if you search back through the archives. There is an episode on water rights. That’s an example of evergreen content. Some topics are tie into something that is trending in the news. For example, there will usually be an updated economic outlook once a quarter, or an interest rate adjustment. But this year, things have been changing so rapidly, that once a quarter isn’t enough. The impacts are being felt fast and furious. I try to cycle through the major segments in the industry including residential, multi-family apartments, retail, hospitality, office and industrial. To answer your question specifically,  I have a number of sources that I refer to regularly to when I’m researching topics. The major brokerage houses have research departments. I read those reports and often use them as a launch pad for deeper research. I also look at the reports from the research wings of Fannie Mae and Freddie Mac. The folks at Fannie Mae under chief economist Dr. Doug Duncan do some of the best research in the business. I pay attention to what some of the most tenant friendly politicians are saying. For example I regularly receive press releases from certain elected officials at the Federal and State level. They often put out a press release when they table draft legislation. I follow the work of Dr. Chris Martenson, Dr. John Campbell, Simon Black, David Stockman, Jim Grant the author of Grant’s Interest Rate Observer. I follow John Mauldin. He’s an economist who is one of the best connected guys in the business. He has central bankers on speed dial on his phone. I speak with other investors. I speak with Robert Kiyosaki, Russell Gray, Robert Helms, Brien Lundin, folks who are specialists in their specific area. I also mine Business Insider, the Wall Street Journal, Apartments.com, the Financial Times, the Globe and Mail, the National Association of Realtors. What I’ve shared is a subset of a long list of regular sources. But when I find a story that I think will be interesting, I’m not merely retelling the story from a newspaper. I will go to the original sources and construct a completely new perspective on the story based on my own observation. For example, the story on yesterday’s show was about a landlord defending a discrimination complaint in New Jersey. It was reported in a local Northern New Jersey publication. I went to the 10 page transcript of the settlement ruling from the New Jersey Attorney General’s office in order to make sense of the story. If the source of the story is in a fringe publication, I will look and see if the story has made it into some of the more mainstream publications. I don’t want to be seen as part of the lunatic fringe. There are some days when I’ve completed the research and the summary for an episode and I decide against publication. Those are difficult decisions.  Thank you Ryan for a great question. 

From time to time we come across the weird and wonky news story. Today’s show is precisely one of those. It’s one of those stories that seems to defy logic. But then again, in the litigious good ol USA, even the most seemingly benign things can be cause for a lawsuit. The owner of Ivy Lane Apartments in Bergenfield New Jersey settled a discrimination complaint and agreed to pay $30,000 to a man who applied to live in the apartments. The fact is, he didn’t actually apply. He called the leasing office and asked about living in the apartment complex. According to the story, Ricardo Moran visited Ivy Lane Apartments to ask about renting a one-bedroom unit and alleged that the management company, Tower Management said he needed to meet a $33,000 minimum yearly income requirement. which didn't take into account public assistance. Mr. Moran, who has a disability, planned to pay at most $386 out of pocket to cover the monthly rent of $995, paying the rest with Section 8 vouchers. He left Ivy Lane without filling out a rental application, according to the details in the 10 page court filing. He also never mentioned that he would be using a section 8 voucher to make up for his income shortfall. He simply left and assumed that he would not qualify. According to New Jersey law, it is unlawful for any person to refuse to rent property to a prospective tenant because of source of lawful income, including a Section 8 housing voucher, to be used for rent. But the tenant was never refused because they never actually applied. They made an assumption based on an incomplete conversation. Somehow, the property management company was alleged to have discriminated against the prospective tenant. The motion was started in April of 2010 and was finally settled more than a decade later in October of 2020. Some property management companies have a practice of looking up the records of the landlord tenant tribunal for cases having been brought against a prospective tenant. Unless the tenant was evicted, the fact that they appeared before the tribunal can’t be held against the tenant.  Even if there are a dozen such cases against the same tenant, unless one of those cases resulted in a judgement against the tenant or an eviction, that information can’t be used in making a tenant qualification decision. The New Jersey Attorney General’s office has held up the case a setting a precedent in the State for how discrimination cases should be handled. I’ll be the first to say that anti-discrimination laws are vital and important to maintaining a just society. I can’t stand it when I see examples of injustice because someone has been discriminated against for their gender, their religious beliefs, their cultural background, sexual orientation or any lengthy list of possible discrimination. In this particular instance, the tenant was not turned down because they never actually applied. Holding the landlord responsible in this instance seems to cross a line in my view. But then again, I’m not a human rights lawyer and perhaps I’m missing something. So why am I telling you this? As a landlord, as this case demonstrates, you might be held liable for something that you said, or more importantly didn’t say when it comes to human rights complaints. If the tenant has simply asked whether a Section 8 voucher could be used in place of the income qualification, the whole decade long legal case could have been averted. The case puts the responsibility on the landlord to communicate the rental policy fully and completely in writing. So Tower Management wrote Mr. Moran a check for $30,000 and updated their policy and provided training for their property managers on the policy.

On today's show, I’m making a prediction on the economic outlook for Q4 and the broad impact I project it to have on real estate markets. The economy in Q4 is going to take a hit. We saw a resurgence of employment, a modest increase in consumption and a return to limited travel in Q2 and Q3. But new unemployment claims remain historically high. Prior to the pandemic, the US economy registered an average of about 250,000 new unemployment claims in a normal week. Since the pandemic, new jobless claims have been above 700,000 every week. The first 6 weeks of the pandemic registered 32 million job losses. We are still in a very troubled economy from a labor standpoint. The other major driver of the economy is consumption. The law of averages tends to apply. If the population hasn’t increased, and people are still eating three meals a day, the amount of food consumed on average won’t fundamentally change when averaged over the course of a year. Toilet paper sales surged in Q2 when it looked like there might be shortages. Those who were in the business of selling toilet paper might have felt like they won the lottery. But on average, if toilet paper sales surged in Q2, it makes sense that they might fall below average in Q3 or Q4. On average, toilet paper consumption at the final point of use, next to the toilet over the longer term isn’t going to increase just because there was a lockdown. There is a business cycle in retail that has historically held true. Many retail businesses generate 50% of their annual profit in Q4 during the period between Thanksgiving and the end of the year. But this year could be different. We have many areas going into a new wave of Covid-19 outbreaks. This will mean a reduction in business activity, a reduction in social interaction, a slowdown of commerce. If family members are not traveling for the holidays in large numbers, what will that mean for retail sales? If family gatherings are going to be scaled back this year, it makes sense that gift giving will also be scaled back. Some gifts will be sent by mail or delivery service. But it makes sense that fewer gifts will be bought this year. The big question is whether people will treat themselves to a gift on a larger scale to make up for it? It’s clear to me that retail sales in North America in Q4 will be down from last year. It doesn’t take a huge crystal ball to predict that outcome. So what does this mean for you as a real estate investor? It means that some tenants will struggle to pay rent. I know of several landlords who are now getting eviction judgements against tenants who have stopped paying, depending on the jurisdiction. Those property owners whose cash reserves are depleted may face a more dire situation. Lenders will face the difficult decision whether to extend forbearance terms or declare the loans to be in default. In my opinion, you need to be hunkering down for another economic winter, amassing cash reserves in order to weather another storm of unknown duration.

Dax Mitchell is based in Fort Worth Texas where he specializes in industrial assets. On today's show we're talking about the various segments of the industrial market and the market outlook that has emerged in a hot segment. Dax can be reached at Mag Capital Partners. His website is magcp.com and he can be reached by email at dax@magcp.com.

I had a conversation with George Ross earlier this week where we talked about the outcome of the election. George offered his perspective on the election outcome and what it might mean for real estate investors. 

On today’s show we’re talking about the tax changes that could affect real estate investors following the US election. The 2017 changes to the tax code brought a number of new initiatives that were very beneficial to real estate investors. Top of the list were three changes. 1) Bonus Depreciation 2) Opportunity Zones 3) Step up in basis Robert Kiyosaki’s Rich Dad advisor on accounting is Tom Wheelright. Tom has is the author of the best selling book called Tax Free Wealth. It’s newly updated and current to the tax code changes as of 2018. Tom has taken the time to read through the proposals from the Biden campaign to understand what they could mean for real estate investors. Tom’s analysis is that each of these moves would be bad for real estate investors. We should be moving to take advantage of them in 2020 while we still can. Of course we don’t know for sure what the new administration will do. What was promised during the election campaign may or may not be implemented in practice. The Biden campaign vowed to reverse the Trump tax changes and go a step further by eliminating the sheltering of capital gains under section 1031 of the tax code, the so-called 1031 tax deferred exchange. But even if bonus depreciation gets cancelled, 1031 gets cancelled, and step up in basis gets cancelled, there is a good chance that opportunity zones would survive. According to a new report in the industry magazine called “Accounting Today”, there is an article that sheds some light on the creation of the opportunity zone concept. One of Biden’s top economic advisers co-wrote the white paper that led to their creation. Vice President elect, Kamala Harris, has pointed to Opportunity zones as a way to spur entrepreneurship. And their campaign website listed ways of reforming, rather than repealing, the policy. Steve Glickman, is a former Obama administration official who pushed for the incentives.  He now runs a consulting firm called Develop Advisors, specifically for investors looking to create opportunity zone funds. Steve used to be the leader of the Economic Innovation Group, a bipartisan Washington based research and policy organization. When he was at EIG, he was the architect and EIG conceptualized the program and drafted the underlying legislation. It was cosponsored by Tim Scott from South Carolina and Cory Booker, a Democratic Senator from New Jersey. Last month, the Government accountability office issued a 28 page report on Opportunity zones. In that paper GAO is identifying two matters for congressional consideration, including that Congress consider providing Treasury with authority and responsibility to collect data and report on OZ’s performance, in collaboration with other agencies. As part of that deliberation, Congress should also consider identifying questions about OZ’s effects that it wants Treasury to address in order to help guide data collection and reporting of performance, including outcomes. enator Scott has said his top priority is adding reporting requirements. A bill he introduced in December would direct the Treasury to post data annually on investment funds claiming the breaks, and to track job growth, poverty reduction and other economic indicators at five-year intervals. Oregon Senator Ron Wyden, the top Democrat on the Senate Finance Committee, proposed a reporting bill with lots of other restrictions attached. It’s possible that we may see a re-assignment of opportunity zones. Critics have taken issue with the selection of certain zones, such as a trendy arts district in Los Angeles and swaths of Brooklyn. And some have suggested replacing those that don’t meet traditional ideas of struggling neighborhoods with zones that do.

Today is another AMA Episode. Ramon from Los Angeles asks, I have several investment properties with reasonably low debt, <50% LTV, >1.6x DCR. With interest rates so low and the potential for inflation caused by central bank currency printing, I am considering refinancing a few properties to increase their debt, 70% LTV, 1.2x DCR.  In addition to letting this potential inflation help wipe away the debt over time, I will get the added benefit of pulling cash out to take advantage of opportunities which may become available if distressed sellers start to sell and foreclosures begin to hit the market. On the other hand, by doing this I would be adding risk by increasing my debt service at a time when there is downward pressure on rents and increased rent collection risk. What is your perspective on responsibly loading up on as much low interest debt as possible? Money comes to you in one of three ways. 1) Earned income 2) Residual Income 3) Capital Gains The choice of how much debt to take on is a function of several factors. If you take on more debt, the residual income from the business will go down. A lower debt service and a higher debt coverage ratio means higher cash flow for you at the end of each month. If your goal is cash flow, then taking on more debt is going against your residual income or cash flow objective. But if you’re willing to defer a portion of the residual income in order to grow the portfolio and increase your total portfolio, that could be a winning strategy. I’m going to make up some numbers following your example. Let’s say that you have a portfolio of $10M and you’re going to refinance the portfolio to increase the loan to value ratio from 50% to 70%. So you’re going to take on an additional two million in debt. The debt coverage ratio will fall from 1.6 to 1.2. You’re quite right in pointing out that the lower debt coverage ratio has more risk associated with it. The risk is that the portfolio might experience negative cash flow if you have something unexpected happen. You’re going to borrow an extra $2M within that $10M portfolio in our example. This will give you the ability to put down up to $2M on a new property which could significantly expand your portfolio. But as you rightly pointed out, you would be taking on more risk. What if instead of sinking all $2M of new money into a new project, instead you invested $1.8M. You could put the extra $200,000 in a reserve account to protect the portfolio from any short term cash crunch, if the need arises. It will require a lot of discipline not to spend that money. To summarize, borrowing additional funds to buy another project, and increase your war chest cash reserve on your balance sheet could be the best of both worlds. You can improve the safety of the entire portfolio and at the same time, acquire another project.

The world is filled with news articles that don’t make sense. I get bent out of shape when I read an article that is downright ignorant. When I say ignorant, I mean lacking in basic education. The worst part is that these articles are getting wide circulation and feeding mis-information on a large scale. On today’s show we’re talking about one such article about the condo market published earlier this week in the Huffington Post. There have been numerous articles that are similar speaking about the fall in rents in New York, San Francisco, and other expensive coastal markets. The article is entitled, “Canada’s Condo Markets Face Perfect Storm As Rental Rates Tank, Costs Jump” The story goes on to say, “Add yet another to the many imbalances in Canada’s pandemic economy: Renters are catching big breaks as rental rates drop, while condo owners ― particularly investors ― are looking at potentially rough times ahead. In fact, for condo owners, just about everything that could go wrong ― from bad construction and rising insurance costs, to rental rates that can’t cover mortgage payments ― is going wrong.” Stories like this are just so ridiculous. They imply that the pandemic is to blame for the plight of these condo investors. The implication is that these were good investments to begin with, and the pandemic turned them into bad investments. The fact is, these investments would have never met my criteria. Let’s look at some specific examples. In Toronto right now there are about 30,000 condo’s for rent in the core of the city. That’s a lot of inventory. No surprise that rental rates have fallen.  The city of Toronto attracts about 125,000 new residents a year and in a traditional year, there are about 35,000 units of new construction. The imbalance between demand and supply is one of the main reasons that prices have been continually rising. But immigration is down this year because of the pandemic. So fewer people are moving into the city and a lot of that new supply coming into the market is competing with existing inventory. For those of you on this podcast, nobody is going to be shocked to hear that $1,600 a month in rent on a $500,000 investment is not going to pencil. You don’t need to pull your calculator out to know that those ratios don’t work. But here’s the crazy thing. Realtors all over are selling these types of properties to unsuspecting amateur investors. They won’t cash flow, but appreciation has meant that all you needed to do was sit on them and time would take care of everything. The memory of down years is a distant memory.  When you invest in shares of Tesla, you look at the last few years and the stock has consistently gone up. Maybe you decide to buy shares of General Electric. You tell yourself that General Electric is now a bargain after having fallen 75% from it’s highs a few years ago. All of these plays are pure speculation of the same type that wall street investors use every day. These investments are not professional investments. They’re speculations, and are not based on fundamentals. When I make an investment in a property or a new construction project, I’m very clear on where the profit is going to be generated. That doesn’t mean that you won’t encounter surprises or changes in market conditions. But at least I’m clear on the day to day cash flow. I’m not speculating that prices will go up, simply because they’ve always gone up. When I underwrite projects, there is no speculation on the value going up. The investment has to make sense today, in today’s dollars with today’s market conditions.

On today’s show we’re going to take a brief detour from the world of real estate investing to unpack one of the largest technology announcements to come out this year. Unless you are involved deeply in the guts of the high tech industry, you may have a hard time understanding the significance of the latest Apple announcement. Prior to moving into the world of real estate investing, I was a microprocessor designer and I used to manage microprocessor development teams. I have processors designed into all kinds of applications all over the world. This is a world that I know deeply, so I thought that taking 5 minutes to share a perspective on the latest announcement by Apple would be a good use of 5 minutes. So here we go. Last week Apple announced that they were moving away from the Intel architecture of chips to the ARM architecture. The question is, “What does this really mean for you as a user of these devices?” A few years ago, they upgraded the operating system on the iPhone to include many of the elements from MacOS. There are three primary operating systems in use in computers today. Windows which has majority share of the desktop computer market, Android which has majority share of the mobile devices, and Unix with all of the various linux variants that make up the majority of the server world. The Mac Operating System was based on Unix technology. It's the most robust industrial strength operating system out there, and is the least prone to security breaches. So when Apple introduced many of these elements to the iPhone, the iPhone really became a robust computer. Apple is trying to find a way to blur the lines between the desktop computing platform that you find on their desktop computers and notebooks, and the mobile computing platform that you experience on the iPhone and iPad family of devices. Mac applications don’t work on the iPhone and iPhone applications don’t work on the Mac, up until know. The second major difference comes in the realm of battery life and overall performance. The way to think of the difference between the Intel chips and the newly designed Apple chips is like comparing the difference between a Ferrari and a Volkswagen. The Ferrari is much more expensive. It’s a much faster car under perfect conditions like a race track. But in real world rush hour traffic conditions in Los Angeles or Dallas, a Ferrari and a Volkswagen will perform remarkably the same. The Ferrari might beat the Volkswagen through a few traffic lights, but the real difference will be small. Most importantly, the Ferrari will use a lot more fuel to get the same job done. So which car is truly better? The answer is it depends. The Intel chips are more like the Ferrari and the Apple M1 chip is more like the Volkswagen. The Volkswagen will use a lot less fuel. The Apple M1 chip will consume less power than the Intel chip and therefore will have longer battery life. Apple is claiming up to 18 hours of video streaming on a Macbook. No other device on the market comes close to that kind of battery life. 

On today’s show we’re talking about a single word. The problem with this single word is that it’s ambiguous. We often think that we know the language and what it means. But the truth is unless you’re really clear on exactly what you mean, very simple words can lead you down a dead end path. Today’s show is focused on a simple word that has four letters. When projects run into difficulty, the culprit is often a failure in the plan. This year, in the year 2020 with all of the global dislocations that have  befallen our economies most business leaders would bristle at the notion that the plan was to blame for the difficulties being experienced. We’ve had a global pandemic. We’ve had government mandated shutdowns. We’ve been ordered by our governments not to conduct business. How can you sit on you high horse and say that the plan was to blame? I heard a business leader tell me in the past week, he said “We had a plan, and the plan couldn’t be executed.” The Project Management Institute is the globally recognized leader in project management certification. If you’re going to be a professional project manager, you’re going to take a bunch of courses and at the end take a lengthy exam. Finally you’re a professional project manager. The PMI has a lengthy publication called the Project Management Body of Knowledge. This document breaks down project management into 5 distinct process groups, 10 knowledge areas, and 49 distinct processes. The project plan itself has an outline of 10 chapters. According to PMI, a plan is a formal, approved document used to guide both project execution and project control.  A plan is a deliverable. It’s a document which you can point to. It’s a noun. Therein lies the problem. When you have a plan, then the work to produce the plan is done. When you think that the plan is a noun, you completely miss the fact that the word plan is also a verb. A verb is an action word in most languages. You can conjugate the verb. When you think of the plan as a noun, it often has a finite end-point. The plan is complete, it’s done. We now have a plan. We obviously don’t want to do an incomplete job of planning, no more than we want to do an incomplete job of anything. In order to achieve excellence, things need to be taken to completion. But plans are different. Plans, despite our ideals are never done. They’re continually being pushed off track by forces. I may have a plan to sail the ship from New York to Gibraltar. I plot the course based on the direction I need to go. But there’s wind, there is current, there are local waves that can instantaneously turn the ship so that from one second to the next it’s not facing the intended direction. You have to always be adjusting course. In fact, you are almost always off course.  There are a few miniscule instants in time when the ship is actually on course. The rest of the time it’s off course, trying to get back on course.  Once you get out on the water, the weather you thought was going to be part of your journey changes. You may have to take a detour of 1,000 miles in order to avoid that hurricane that changed direction. You see, in order to be useful in the real world, the word plan is a verb first and a noun second. The folks at PMI are great. But they’re academic. They’ve studied project management about as deeply as it is possible to do so. We see a verb being more empowering than the noun.